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July 12, 2012

Best 5 Investment Picks for Midyear 2012

AdvisorOne sums up the best of what’s happening in stocks, bonds, funds and more

Money changes hands on the floor of the Chicago Board Options Exchange. (Photo courtesy of CBOE.)

As we reported last November in Best 5 Investment Picks for 2012, the smart money was positioning portfolios for growth, based on strategists’ confidence that cash-rich U.S. companies were well disposed toward dividends and that another recession was far from likely.

That was then. Considering the global markets’ second-quarter plunge on eurozone worries—not to mention the fiscal cliff that the U.S. faces as the presidential election nears—investors now understandably wonder if their money is still safe.

In a market call on Tuesday, OppenheimerFunds Chief Investment Officer Art Steinmetz acknowledged that eurozone woes and the fiscal cliff are tremendously difficult to handicap. “It seems that we are in thrall to the caprices of politicians more than in the past,” he said.

Asked if it was worthwhile to wait to buy stocks until after the election, however, Steinmetz was adamant. “I would not let the elections stop me from getting my portfolio right today,” he said.

Recession remains unlikely, noted his colleague, Chief Economist Jerry Webman: “We think the most probable case is a little more Europe, a little more crisis, a little more central bank action, and we’ll keep bouncing along. The problem is that all of this creates uncertainty, and the markets hate uncertainty.”

Overall, Steinmetz said, mutual fund flows in the last six years have shown a net drain in U.S. equity funds, with a slight flow to emerging markets and a huge flow to fixed income. Indeed, he said investors’ overwhelming faith in the bond market as a safe haven is starting to look a lot like the dot-com bubble of the late 1990s.

So what’s an investor to do? Read on for AdvisorOne’s midyear update on the best investment picks for 2012.

“If you look at the total return in bonds, you can’t go down below zero,” Steinmetz said. “The possibility of a loss is greater than ever because yields are lower than they’ve ever been. On the other hand, stocks have gotten cheaper and cheaper relative to bonds.”

(Remember, investors, that the markets of 2012 are tightly correlated due to macroeconomic events, which means that many people are overlooking companies’ fundamentals. Those are ideal conditions for stock pickers.)

“Over the next seven years, stocks will outperform bonds, and investors are positioned exactly the wrong way,” said Steinmetz, who likes the finance, health care, tech and retail sectors. And, he added, beware materials and energy.

Taking a contrarian stance, Steinmetz also gave European stocks a mention, saying they look attractively cheap these days. “No one’s saying we have a bullish outlook on the European economy,” he said, “but don’t forget that many European companies have a global customer base that doesn’t depend on the European consumer. That represents an opportunity, in Oppenheimer’s view. Don’t look at countries, look at companies.”

The German technology conglomerate Siemens, for example, saw its most successful year in its history in 2011, but the stock reached a 52-week low of $82.23 earlier in July, off 42.8% from its $138.23 high. NASDAQ’s July 8 “GuruFocus” list of 52-week lows notes that some stock pickers have used this as an opportunity to buy Siemens.

2) Bonds

The U.S. Treasury on Wednesday auctioned its benchmark 10-year notes at a yield of 1.459%—a record low, confirming most analysts’ belief that the best way for investors to go in the fixed-income market is toward higher-yielding bonds with good underlying fundamentals.

A day earlier, the LPL Financial market strategist Anthony Valeri warned in a fixed-income call note that the auction might test demand as investor fatigue with lower yields sets in.

But on the positive side, Valeri wrote, “A lack of new issuance, strong reinvestment needs, attractive valuations and above-average income continue to support high-yield bonds despite equity volatility. The average yield spread of high-yield bonds is currently 6.5% above comparable Treasuries.”

Money is pouring into fixed income, especially governments, including municipal bonds with long durations, Steinmetz said. “People like them for the tax exemption, but they should look at shorter-term muni bond funds. People don’t understand the risks they’re getting into.”

Mirroring Valeri, Steinmetz pointed to the virtues of high yield: “We think it’s an excellent time to clip the coupons on high-yield corporates and leveraged loans,” he said.

3) Funds

Looking for a solid exchange-traded fund to invest in? The S&P Capital IQ ETF analyst Todd Rosenbluth makes no bones about what he believes is a top pick: the iShares S&P 100 Index Fund (OEF), which offers a basket of dividend-yielding stocks and a low expense ratio of 0.2%. Apple is the fund's largest holding.

“These are the 100 largest stocks within the S&P 500 Index,” Rosenbluth told AdvisorOne on Wednesday. “These are the heavyweights. The index and the fund have outperformed the broader S&P 500 Index year to date because investors are gravitating more to the safety of the largest of the large caps.”

These mega-cap companies tend to have stronger balance sheets, a history of paying and increasing their dividends and the ability to deal with market volatility. S&P Capital IQ likes many of the mega-cap holdings in this ETF—Apple, GE and Exxon Mobil, for example—from a valuation standpoint.

As for mutual fund favorites at S&P Capital IQ, analyst Dylan Cathers in a July 9 MarketScope Advisor report names three strong performers in the high-yield bond universe that “have been best able to trudge through the recent spate of unfavorable economic news” in the last 12 months ended July 6:

Ivy High Income Fund (WHIAX). The top performer on Cathers’ list, the Ivy High Income Fund posted a total return of 9.6% over the past 12 months. By comparison, the high current yield funds average over that same span was 5.2%.

Westcore Flexible Income Fund (WTLTX). This fund's total return over the past year was 8.8%, 360 basis points ahead of the high-yield funds group.

TIAA-CREF High-Yield Fund (TIYRX). “While not reaching the level of outperformance of WHIAX or WTLTX, TIAA-CREF High-Yield Fund outperformed the high current yield funds group by a very strong 270 basis points over the year ended July 6 on a total return basis,” Cathers writes.

4) Alternatives

As investors chase yield this year, they’ve pressured their advisors to look into alternatives to the usual stocks and bonds that normally fill out their portfolios.

Options, as a result, are an increasingly popular item in an advisor’s toolbox. In fact, says options evangelist Eric Cott of the Options Industry Council (OIC), 48% of advisors used options in 2010, and one in three say they intend to increase their use in the future. Individual investors, meanwhile, are turning to options to trade in triple-digit-priced stocks such as Apple and Google, The Wall Street Journal reported this Tuesday.

What does all this mean for advisors? It means that now is a good time to figure out just how options can be used in lieu of purchasing stock.

According to Alan Grigoletto, the OIC’s director of education, the cost of buying one option is significantly less than the cost of buying the equivalent 100 shares of any high-priced, volatile stock.

For example, Grigoletto said in a Wednesday phone interview, if an investor thinks a stock trading at $550 per share will go higher, he or she might buy a call option with a strike price that’s 5% or 10% out of the money. In other words, the investor is betting that the stock underlying a call will have risen when the strike price is exercised.

“All the investor can lose is what he paid for that option,” Grigoletto said. “So if the stock goes from $500 to $0, whatever he paid for that option is what he can lose, and that obviously would not be anywhere near the cost of the stock. Let’s say it’s an option that costs $500, then the investor will lose $500 as opposed to losing $50,000.”

That’s the risk. The reward is that the investor is paying a small amount of money to get a position in a very high-priced stock. If the price rises as the investor had hoped, he or she can either sell the option for a profit or exercise and own the shares outright.

“Let’s say the stock went to $600, and he happened to own a $575 call, and he paid $5 for that $575 call. So $600 minus $575 is $25, less the $5 he paid, and the investor would have a $20 profit on that option,” Grigoletto said. “In a nutshell, you’re taking less risk by taking the position with an option than if you took the risk by purchasing the stock outright.”

5) REITs

U.S. real estate investment trusts significantly outperformed the broader equity market in the second quarter and first half of 2012, as well as over the past 12 months, the National Association of Real Estate Investment Trusts (NAREIT) reported Wednesday.

In the second quarter of the year, the total return of the FTSE NAREIT All REITs Index was up 4.55%, the FTSE NAREIT All Equity REITs Index was up 4% and the FTSE NAREIT Mortgage REITs Index was up 8.53%—all this while the S&P 500 Index fell 2.75%.

For investors interested in dipping a toe into this market, shopping mall REITs are worth a look.

NAREIT notes that the retail sector is the best REIT performer this year, and within this sector there are eight mall REITs with a combined market capitalization of $82 billion as of June 29. The average dividend yield for the subsector is 2.75%, while the year-to-date total return is 22.71%.

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